THE EFFECTS OF CREDIT RISKS ON LOANS PORTFOLIO AMONG SACCO ...
Transcript of THE EFFECTS OF CREDIT RISKS ON LOANS PORTFOLIO AMONG SACCO ...
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THE EFFECTS OF CREDIT RISKS ON LOANS PORTFOLIO AMONG SACCO’S IN
THARAKA NITHI COUNTY, KENYA
MARY CIRINDI JOSEPH
A RESEARCH PROJECT SUBMITTED TO THE SCHOOL OF MANAGEMENT AND
LEADERSHIP IN PARTIAL FULFILLMENT OF THE AWARD OF THE DEGREE OF
BUSINESS MANAGEMENT AND LEADERSHIP (BML) OF THE MANAGEMENT
UNIVERSITY OF AFRICA
SEPTEMBER 2017
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DECLARATION
This project proposal is my original work and has not been presented for a degree in any other
University
Signature:………………………….. Date:………………………………….
MARY CIRINDI JOSEPH
ADM NO ODL/BML/5/00225/1/2015
This project proposal has been submitted for examination with my approval as the University
supervisor
Signature:…………………………. Date:…………………………………….
Dr. JOHN CHELUGET
The Management University of Africa
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DEDICATION
I dedicate this research project to my husband and children for the support and prayer through
the entire process.
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ACKNOWLEDGEMENT
It is befitting that my utmost acknowledgement goes to the almighty God for giving me strength
and patience while doing this work. I am also highly indebted to my supervisor, Dr. John
Cheruget for his valuable guidance from the time of proposal writing through to the finalization
of the project. Deep gratitude goes to all my lecturers at Management University of Africa for
the guidance and encouragement in pursuing this course to completion even when I thought I
could not manage it, and for helping me in the preparation through to the final report writing.
Special acknowledgement goes to my employer Postal cooperation of Kenya for the financial
support and time to complete the coursework and generous contribution of secondary data. To
my entire family members and colleague thank you for encouragement and all the support you
accorded me during my study period. I cannot forget to thank all those who assisted me in typing
this work. And all those i have not mentioned individually, I say, Thank you a lot. God bless
you.
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ABBREVIATIONS
BOSA Back Office service activities
CAMEL Capital adequacy, assets quality, management, earning and liquidity
CRB Credit regulatory bureau
FOSA Front office services activities
FG Focus group
FSD Financial sector deepening
KIE Kenya industrial estate
LPM Loan performance management
MFI Micro-finance institutions
NPL None performing loans
SACCO Savings and credit co-operative society
SASRA Sacco’s societies regulatory authority
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TABLE OF CONTENTS
DECLARATION ....................................................................................................................... ii
DEDICATION .......................................................................................................................... iii
ACKNOWLEDGEMENT ......................................................................................................... iv
ABBREVIATIONS .................................................................... Error! Bookmark not defined.
TABLE OF CONTENTS .......................................................................................................... vi
ABSTRACT ........................................................................................................................... viii
CHAPTER ONE .........................................................................................................................1
INTRODUCTION ......................................................................................................................1
1.0 Introduction ......................................................................................................................1
1.1 Background of the Study .................................................... Error! Bookmark not defined.
1.2 Statement of the Problem .................................................. Error! Bookmark not defined.
1.3 Main Objective of the Study ..............................................................................................7
1.3.1 The Specific Objectives of the Stud ................................ Error! Bookmark not defined.
1.4 Research Questions ............................................................ Error! Bookmark not defined.
1.5 Significance of the Study ..................................................................................................8
1.6 The Scope of the Study .....................................................................................................9
1.7 Limitation of the Study .....................................................................................................9
CHAPTER TWO ...................................................................................................................... 10
LITERATURE REVIEW .......................................................................................................... 10
2.0 Introduction ..................................................................................................................... 10
2.1 Theoretical Literature Review .......................................................................................... 10
2.2 Empirical Literature Review ............................................................................................ 17
2.2.1 Risk Identification......................................................................................................... 18
2.2.2 Risk analysis and Assessment ......................................... Error! Bookmark not defined.
2.2.3 Risk Monitoring and Mitigation .................................................................................... 22
2.2.4 Credit Risk Management Measurement ......................................................................... 24
2.3 Summary and Research Gaps ........................................................................................... 25
2.4 Conceptual Framework .................................................................................................... 29
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2.5 Explanation of Study Valuables ....................................................................................... 30
CHAPTER THREE ................................................................................................................... 32
RESEARCH DESIGN AND METHODOLOGY ...................................................................... 32
3.0 Introduction ..................................................................................................................... 32
3.1 Research Design .............................................................................................................. 32
3.2 Target Population ............................................................................................................ 32
3.3 Sample and Sampling Technique ..................................................................................... 33
3.4 Research Instruments ....................................................................................................... 33
3.5 Pilot Study ...................................................................................................................... 33
3.6 Data Collection Procedure ............................................................................................... 34
3.7 Data Analysis and Presentation ........................................................................................ 34
3.8 Ethical Considerations ..................................................................................................... 35
CHAPTER FOUR ..................................................................................................................... 38
RESEARCH FINDINGS AND DISCUSSIONS ....................................................................... 38
4.0 Introduction ..................................................................................................................... 38
4.1 Data Collected and Analyzed ........................................................................................... 38
4.2 Descriptive Statistics ........................................................................................................ 39
4.3 Factor Analysis ................................................................................................................ 47
4.4 Summary and Implications of Findings ........................................................................... 48
CHAPTER FIVE ........................................................................ Error! Bookmark not defined.
SUMMARY, RECOMMEDATIONS AND CONCLUSION ...... Error! Bookmark not defined.
5.0 Introduction ....................................................................... Error! Bookmark not defined.
5.2 Conclusions ..................................................................................................................... 50
5.3 Policy Recommendations ................................................... Error! Bookmark not defined.
5.4 Limitations of the Study ................................................................................................... 52
5.5 Suggestions for further study ........................................................................................... 53
REFERENCES ......................................................................................................................... 54
APPENDICES .......................................................................................................................... 56
APPENDIX I: LETTER OF INTRODUCTION ....................................................................... 56
APPENDIX 1I: QUESTIONAIRE ............................................................................................ 57
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ABSTRACT
Savings and credit cooperative societies (SACCOs), operates in an environment of considerate
risks and uncertainty. Credit portfolio is one of the main challenges faced by financial
institutions as well as the savings and credit cooperative societies in many parts of world. Thus,
the main objective of the study was to establish the effect of credit risk management on the loan
portfolio among SACCOs in Tharaka Nithi County, Kenya. The study specific objectives
included establishing the effects of credit risk identification procedures on loan portfolio,
assessing the effects of risk analysis procedures on loan portfolio, determining the risk
monitoring procedure on loan portfolio and finally examining the risk management mitigation
measures on loan portfolio by SACCOs. The study applied the descriptive research design and
the target population of the study was 35 registered SACCOs in Tharaka Nithi County. The study
applied the a systematic sampling procedure to identify the SACCOs and the sample size was all
the SACCOs in the county since they were small in number. The data collection instrument was
a questionnaire and before administering the questionnaires, a pilot study was conducted in the
neighboring Meru County with six SACCOs to establish the validity and reliability of the study
instruments. Qualitative data was checked for completeness and later analyzed using Statistical
Package for Social Science (SPSS) version 22. The study findings indicated that majority of
savings and credit cooperative societies in the County applied various credit risk identification
methods on loan collection management. The most popular method of promoting credit risk
awareness amongst the SACCO staff was through regular trainings, appraisal and constant
supervision on the credits management staff. However, use of credit manual was not regularly
used although its application is supposed to go hand in hand with regular meetings and
supervisions. Most SACCOs followed the three month credit default policy period as the
benchmark for credit default. However, it also became apparent that the SACCOs used a
combination of credit default policies as opposed to just sticking to one. In most SACCOs credit
risk management practice had a positive impact since it ensured there was efficiency in carrying
out obligations to meet the intended objectives. Credit risk managers in SACCOs used a
combination of methods but the most favored one was the credit limit followed by credit
approval and credit control policy respectively. SACCOs credit committees, boards of directors
and credit managers respectively were responsible for credit policy formulation . The executive
management also registered a sizeable impact on credit policy albeit somewhat diminished when
compared to the first three avenues of credit policy formulation. The character of the borrower
was the most prominent criteria used in screening of potential borrowers amongst SACCOs. The
SACCOs also set some conditions mainly involving duration of membership and amount saved.
Collateral was also used but it was not the core criteria given that most SACCOs are able to
attach member’s incomes (salaries) and hence use these income flows as security. On the other
hand, SACCOs that do not deal with salaried members, such as those comprising business people
and artisans, were keener on collateral. Majority of SACCOs avoided sale of property, debt
collection agencies and legal action. However, the SACCOs also try to avoid debt and interest
write offs and instead prefer loan renegotiation and restructuring. All in all, letters of credit and
telephone calls appear to be the most preferred first line of defense in dealing with clients who
fall behind their loan repayment schedule.
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CHAPTER ONE
INTRODUCTION
1.0 Introduction
The chapter contains the background of the study, statement of the problem, main
objectives and the specific objectives, research questions, significance of the study,
the scope of the study and limitation of the study.
1.1 Background of the Study
Savings and Credit Cooperative Societies (SACCOs) are mostly private or members
owned intermediaries where members are sole owners through shares holding and
membership is mostly open and voluntary. Savings and credit cooperative societies
are financial organization owned and operated on not for profit basis by its members
according to cooperative principles. Savings and credit cooperative societies in
majority of developing countries have established a deeper and extensive outreach to
the financial marginalized communities than any other type of financial institution
(Njoku, 2007). Savings and credit cooperative societies have continued to provide
savings, credits, financial training at the grassroots level (World Bank, 2012).
However, regardless of savings and credit cooperative societies existence, most
financial sector in low-income countries in Africa and other parts of world countries
seemed to have failed to serve the poor in regards to soft loans as a means of social
economic growth in early 1960s. With respect to the formal sector, banks and other
financial institutions generally required significant collateral, and they seemed to
prefer high income loans clients who were referred to as the bankable clients Graziosi
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(2006). Generally the loans advanced were associated with lengthy bureaucratic
application procedures and sometimes associated with very high interest rate.
Mikwamba (2004) traces first SACCO in Africa to have been introduced in Tanzania
in 1930s and in Ghana in 1959. These savings and credit cooperative societies were
formed to assist villagers improve their social economic conditions. However, the
first entrants into modern savings and credit cooperative societies offering micro
credit in Africa include Ghana, Kenya, Uganda, Nigeria and Tanzania. In many
countries in Africa, savings and credit co-operative society (SACCO) are formed with
the intention of offering alternative source of financing the rural and urban low
income citizens to improve their livelihood. In most cases these savings and credit co-
operative societies are mainly community membership based financial institutions
and they are owned by their members in promotion of their members economic
interests (Graziosi, 2006).
Savings and credit co-operative societies’ level of performance highly depends on the
high loans recovery portfolio. Thus, the policies of execution, debts collection and
discipline level are very important in SACCOs (Njoku, 2007). Also debit collection
need to be carried out with outmost care, constantly and with consistency of
analyzing loan portfolio. The SACCO’S management and loans officers are directly
responsible for the implementation collection action and enforcing both the policies
and procedures. According to Ogilo (2011) the policy framework on credit
administration and credit collection plan need to be based on stages of validation
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prior to loans advancement as agreed on. However, the collection procedures and
discipline should complement with the primary loan portfolio granting and
management plane by the financial institution(Reilly & Brown, 2011).
According to Ogilo (2011) the SACCOs credit management need to deal with the
selection of portfolios which maximizes expected returns and should be consistence
with the individual acceptable levels of risk. Loan collection management should
provide a framework that specifies and measures investment risk. It should also
develop the relationship between risks expected and returns (Ogilo, 2011). The main
assumption is that investment must be considered because the return from the
investment interest has a relationship with the returns from assets portfolio which is
important in credit management (Reilly & Brown, 2011).
Credit risk management is one of the most expensive ventures in any financial
institutions in comparison to other risks in financial institutions (Chijoriga, 2007).
Majority of financial institutions worldwide face varied difficulties, but credit risks is
the most profound compared to others. The main difficulty associated with credit
risks is laxity of credit standards for borrowers, counterparties, poor loan collection
methods, lack of attention and not putting into considering the risk management
policies (Basel, 2009).
According to Mudibo ( 2007) there are a variety of credit risks in the entire processes
and activities of financial institutions lending activities, which include banking books
of credit and credit trading books which are normally exhibited in the journal of
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entries as well as the balance sheet. However, the main purpose of risk management
in savings and credit co-operative societies is to is to adjust the risk rates through
maintaining credit exposure through agreeable limits (Kimanthi, 2007). On other
hand Sinkey (2002) observes that SACCO societies should manage credit risks
inherent with entire loans collection risk both at individual and cooperate credit
transactions.
According to Branch (2005), credit collection procedure has a profound influence
financial stability of a SACCO. However, the main decision in credit management
include decision by finance staff, loan management, asset management and
production innovations. Branch (2005) further observes that credits advanced are
supposed to increase savings and credit cooperative society wealth, sustain savings
and credit cooperative societies value and shareholders demand satisfaction. Mudibo
(2005) also observes that credit management aspect in savings and credit cooperative
society is responsible with updating accounts, encouraging correctness of account,
planning and reporting. Kimathi (2007) stated that prudent credit advancement
strategy by the SACCO is an important practical faction which is supposed to make
the SACCO stable. The practice involve making decisions of committing the savings
and credit cooperative society credits benefit to a planned investment option,
There are different types of savings and credit cooperative societies in Tharaka Nithi
County and they can be categorized into two; Urban SACCOs and Rural SACCOs.
Urban savings and credit cooperative society are formed by members who are either
employed or get consistent monthly income like Trans Nation Sacco which
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membership is drowned from teachers in Tharaka Nithi County. Rural savings and
credit cooperative society are formed by members who actually get inconsistent
incomes through farm produce and small enterprises Kimathi (2007). The main
economic activity commonly done by the members, form the common bond for the
Sacco.
Majority of savings and credit cooperative society in Tharaka Nithi County operate
front office services (FOSA) as well as back office services (BOSA) thereby
accepting deposits from members. They operate savings accounts just like banks as
well as loan accounts which attract interest respectively Kimathi (2007). In Tharaka
Nithi County there are 35 vibrant savings and credit cooperative society with a client
base of over two hundred thousand members. The SACCOs in Tharaka Nithi county
offer a wide variety of services which include salary processing, loan processing,
dividends and deposits processing, produce payment, checks clearance, bankers
checks, interests on savings under front office services (FOSA), farmers account,
counter withdrawal charges, notice fees charges on lump sum withdrawals (Kimathi,
2007).
1.2 Statement of the Problem
The main objective of savings and credit cooperative societies in Tharaka Nithi
County is similar to other SACCOs in Kenya. The main objective of savings and
credit cooperative society is to empower the citizen through savings mobilization,
disbursement of credits and ensuring that the SACCOS’ gets long term sustainability
through careful monetary performance. Kimathi (2007) in a study of savings and
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credit cooperative society in Tharaka Nithi County noted that regardless of vibrant
micro credit facility offered by savings and credit cooperative society, many SACCOs
are faced by poor credit portfolio investment decisions and mismanagement which
makes many savings and credit cooperative society to perform poorly. However,
according to Sacco Society Regulatory Authority report of 2011, loans disbursed by
savings and credit cooperative society to memebers accounted to 30% of total loan
assets.
SASRA (2011) also observed that the quality of loan portfolio was the biggest
challenge because the average non-performing loans (NLP) accounted to 10% for all
savings and credit cooperative society which is contrary to SASRA regulations which
states that the level of none performing loans should not go behold 5%. Observably
the levels of non-performing loans are very high and underline the need for the
savings and credit cooperative society to enforce credit policies to reduce loans none
payment risks. However, the week investment choice and capital foundations and
debts mostly affect and exposes savings and credit cooperative society to credit risks.
However, the current study main objective was to analyzed some of loans risks
management techniques in SACCOs loans portfolio. Some of the study done in
regard to savings and credit cooperative society in Tharaka Nithi county were more
on performance and employee motivation, but none had been done on credit risk
management in the County.
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1.3 Main Objective of the Study
The main aim for the study was to establish and analyze the effects of credits risks
management processes on loans portfolio among savings and credit cooperative
society in Tharaka Nithi County, Kenya.
1.3.1 The specific objectives of the study
The study was guided by the following specific objectives
i. To establish the effects of credit risk identification techniques on loan
portfolio among Sacco’s in Tharaka Nithi County.
ii. To assess the effects of credit risk analysis procedures on loan portfolio
among Sacco’s in Tharaka Nithi County.
iii. To establish the effects of credt risk monitoring on loan portfolio among
Sacco’s in Tharaka Nithi County.
iv. To establish the effects of credit risk mitigation measures on loan portfolio
among Sacco’s in Tharaka Nithi County.
1.4 Research Questions
The study was guided by the following research questions
i. Does the credit risk identification method have any significant effects on loan
portfolio among Sacco’s in Tharaka Nithi County?
ii. Does credit risk analysis have any significant effect loan portfolio among
Sacco’s in Tharaka Nithi County?
iii. Does credit risk monitoring have any significant effects on loan portfolio
among Sacco’s in Tharaka Nithi County?
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iv. Does credit risk mitigation measures have any significant effects on loan
portfolio among Sacco’s in Tharaka Nithi County?
1.5 Significance of the Study
The study shall assist the savings and credit cooperative societies’ management to
appreciate credit risk management portfolio and its impact. Management will also
have opportunity to review credit risk management practices and on the impact of
financial performance. Additionally the study will be important to the academic
community because it broadens the knowledge levels on credit risk management
practices of financial management of savings and credit cooperative societies in
Kenya. The study will provide a basis for upcoming researchers on the areas of credit
risk management. The study shall also assist the credit officers, managers and
directors of SACCOs management with guidelines to follow when choosing
approaches’ to manage and mitigate credit portfolios in savings and credit
cooperative society sectors.
The study will also offer modern-days knowledge on credit risk management methods
that will be applicable in identifying risks and controlling risks effectively in savings
and credit cooperative societies to enhance loan portfolio performance. The SARSA
and Credit Regulatory Bureau (CRB) which are arms of government dealing with
credit regulations will get a referral document to visit when formulating policies
regarding credit taxations management and other regulatory requirements on the
savings and credit cooperative societies. The policy makers will come up with
effectual policies to safeguard the interest of the SACCO loans borrowers and the
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lender on maintaining good participation and relationships. The SACCOs
shareholders and other interested parties will benefit from the study since it will creat
awareness in understanding the circumstances under which the loans operates and the
interest of the SACCOs to reduce conflict between credit officers and loans
beneficially. The study findings will provide basis for future and further research in
the same area.
1.6 The Scope of the Study
The scope of the study shall include all the 35 licensed savings and credit cooperative
societies’ by SASRA and operating in Tharaka Nithi County. The area was
considered appropriate due to high number of savings and credit cooperative societies
and the high rate of loans need by farmers, business people and the employed. The
scope was considered appropriate to satisfy the research objectives guiding the study.
Limitation of the Study
The main limitation was that the study was only applicable to the savings and credit
cooperative societies in Tharaka Nithi County, and the finding might not be a replica
of what happens in other counties in Kenya. However, by extension the findings
could not be applicable to other financial institutions because the loans portfolio
management is different. The other limitation was that the relevance of the
information obtained was limited to the time within which the study was carried out.
The other issue was that SACCOs have different lending policies which keep on
changing and thus, the study findings may be irrelevant to a different area of the
country.
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CHAPTER TWO
LITERATURE REVIEW
2.0 Introduction
The chapter reviewed literature related to savings and credit cooperative societies’
credit risk portfolio management and the literature was from other scholars. The
chapter specifically provided the theoretical literature review, empirical literature
review, summary of the review and research gaps, the conceptual framework and
lastly the summary of the chapter.
2.1 Theoretical Literature Review
SACCOs Performance mostly depend on the quality of if the portfolio according to
Alexandra (2006). Alexandra further stated that the SACCO performance is mainly
determined by governance structures in place and the management. Chipendere
(2009) also stated that despite financial deficiencies experienced by many SACCOs,
they still have loan product tailored to shoot the low–risk borrower members
regardless of vague risk management in some SACCOs. According to SASRA (2011)
Sacco managers need to manage loan portfolio to reduce risks of default because the
cost of loan recovery is high as well as the time take in recovery process a statement
also identified by (Eales and Bosworth, 2008).
According to FSD (2009), Savings and credit cooperative societies normally operate
under objective of maximizing benefit to shareholders to achieve their goals and
standard of living. Mwisho (2011) observes that credit risk management role can as
well conflict with financial observed that the roles can conflict with the financial
practices when the credit management does not put in place tough measure of giving
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out credits and also not monitoring credit risks of the borrowers at individual levels..
Ogilo (2011) observes that the non-performing loans normally leads to stagnation of
SACCOs financial resources and sources. Ogilo, further stated that the effectiveness
of credit risk management largely depend on the managers assessment of loan
defaulting levels in the SACCO . Notably is that the loan portfolio by SACCOs
typically are based the income levels, occupation, employment status and credit
history of the borrowers before lending the money (Higgins, 2009).
According to Ogilo (2011) savings and credit cooperative society societies level of
sustainability mostly is dependent of high recovery level of loans portfolio (Michael
& Sproul, 2008). The policy of loan collection and disciplines are very important and
need to be carried out consistently on loan portfolio. The procedures and policy
regulations for credit collections activities should be based on laid legal procedures of
loans advancement by the savings and credit cooperative society societies (Kimanthi,
2007). As a result it is stressed that collection policies and procedure need to measure
complementary primary loan portfolio management activities (Kablan, 2010).
The savings and credit cooperative society managers mostly rely on the effectiveness
of credit collection set rules and regulations to avert future credit portfolio challanges
(Kimathi, 2007). Kimathi further observed that there are different ways such as
market position of which savings and credit cooperative society societies can identify
credit risks. Also market failures and natural phenomenal can be a good indicator of
either advancing a loan or not and the market failures can also depend on the internal
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process and the action taken by the management. Njoku (2007) stated that savings
and credit cooperative society societies credit risk management need to be active and
vigorous in the process of loan recovery process to enables the savings and credit
cooperative society societies manage loan collection to minimize the losses. The
importance of the savings and credit cooperative society societies loan portfolio
management is also applicable of other financial institutions like bank because tis the
bench mark of standard of debt collection processes all over the world (Focus Group,
2007)
According to Malimba & Ganesan (2009) majority of banking institutions apply
credit risk management portfolio because of the uncertainty associated with
borrowers defaults which is not health for them. The loans repayment uncertainties
remains a major challenge to many banks in different countries of world. (Malimba &
Ganesan 2009). The main approach applied by majority of banks in Kenya included
continues monitoring of loan advanced and unpaid. However, credit monitoring
systems are the key source of uncertainties which include data collection and
generating in the institutions (Uchendu, 2009). In banking sector the market structure
dictates and influence the competition in the banking systems.
On other hand the SACCOs targets borrowers from shareholders, members and other
people who mostly lack collaterals. In savings and credit cooperative society priority
of advancing loans is pegged on priority in disregard of income earned, but they
apply strict loans advancing criteria to low income borrowers leading to the exclusion
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of these needy class of borrowers in financial systems (Cheron et al, 2009). Malimba
& Ganesan (2009) observes that in many times savings and credit cooperative society
fail to accommodate credit risks increases such as loan default or totally defaulting.
2.2.1 Credit Risk Theory
The study applied the credit risk theory by Markowitz (2002). Through credit risk
theory Markowitz, pointed out that credit risk is a challenge which as faced my
loanees for centuries although it not area that has been researched widely till 1930s.
Available literature on loans management portfolio applied the old traditions method
of actuarial in establishing credit risk which is deferent to today credits dynamics.
Markowitz (2002) also observed that in traditional methods the lender somehow
completely depended on history of the borrowers rather that actual and current data.
Higgins (2009) observation of Markowitz credit risk theory insists of three
quantitative approaches to when analyzing credit risks, as the credit offered structures
and approach, appraisal method and information dissemination method which
incorporates awareness by both entities in the deal. Melton introduced the credit risk
theory also referred to as the structural theory which is delivered from a firm’s assets
evaluation by distribution process with continuous limitations. The models were
mainly defined as “structural model” and it is based on variable reflection of specific
issues. The evaluation of this structural groups are represented by the assets
representation where the loss conditions of defaulting are specific. However,
according to (Haggins, 2009) the model of credit default is a continuers process
throughout the life of financial institutions cooperate bond.
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2.2.3 Agency Theory
Another theory applied in this study was the Agency Theory by Tipuric (2008).
Agency theory was a framework used to analyzing conflicting interests between key
stakeholders. It was also additionally developed as a mechanisms for resolving
conflicts (Tipuric, 2008). The agency theory application is extensively prevalent to
the contribution in the discipline of corporate governance. According to Basel (2009)
agency theory is applicable in situations where one party ( the principal) commands
or delegates work to others who are termed as (the agents) to perform certain work..
Agency theory frequently explain the connection in terms of behavioral
distinctiveness and provides mathematic tool for evaluating situations between parties
who lack shared trust. Agency theory is very relevant to credit collection management
by the mangers (Tipuric, 2008). The encouragement or motivation factor for agency
theory development is on the relationship between ownership and control purpose
within financial institutions.
According to Pioneer et al (2006) many financial cooperation’s do not operate
according to maximization principle mainly because of conflict of interest of the
governing entities. Jensen & Meckling (2006) also attribute agency theory as
exchange relation between principals and agents and the for the cases of this study it
apprise to theory describes economic exchange relation between principal and agent
and the case of this study it applies to savings and credit cooperative society
(SACCOs) and other credits advancing entities. However, the principal agent
relations, in which principal delegate their work to agents is just a mare metaphor of
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contracting the agents (Jensen & Meckling, 2006). Thus, the objective of the study
was to determine whether there is optimal contract between principals and agents.
According to Haggins (2009) opines that the agency theory explains the relationship
between the principals as the member and agents in the running of savings and credit
cooperative society. As per the agency theory (Jensen & Meckling,2009) states that
the members who are the owners or principals of the savings and credit cooperative
society, elect the management board as their agent. The principals who are the
(members) delegate the daily running of business to the management board which in
turn hire and delegates authority to the mangers’ (Clarke, 2004).
2.2.4 Loan Portfolio
Loan portfolio are the loans on default or held by the borrowers without payment
(Haron and Hin Hock, 2007). Loan portfolio in many savings and credit cooperative
societies are the major assets and source of interest. The worth of loans collected in
most cases are not pegged on the interest rate they earn, but the probable principle
interest they hold (Jensen & Meckling,2009). In many financial institutions advancing
of loans and mostly inform of cash is the main business of banks and SACCOs and
the loans collection is the main source of income.
In other words, loans in a financial institution are the greatest source of risk because
of the safety of cash awarded and the soundness of the advanced loans to clients.
However, this depends with the keenness, tolerance by credit officers, information
sharing, willingness of the borrower to repay, economic standard of the time, terms
and conditions among others. In many financial institutions credit repayment
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challenges has been there time in memorial characterized with financial losses and
defaults putting these institutions in danger (Kuusela & Ollikainen, 1998). However,
the effectiveness of the loan portfolio management on the credit factions is
fundamental to savings and credit cooperative societies’ soundness and safety. The
Loan Portfolio Management (LPM) is one of the best process applied by financial
institutions to manage and control credit risks (Focus Group, 2007). LPM is very
important and it’s a primary supervisory activity of the management in every
financial institution (Koch, 2000).
Kuusela & Ollikainen (2008) observed that poor loan collection and management
starts when the loan managers fail to notice and evaluate individual borrower. A
continues risk monitoring criteria is paramount in planning and maintaining
individual loans quality in financial institution. Thus, chronological importance of
calculating worthiness of personal loan approval is as important as monitoring loan
performance of the same individual granted the loan. However, with the new
technology and changing information systems, doors are opened to better portfolio
management method in the savings and credit cooperative society societies
(Kimanthi, 2007). With new technology the portfolio manager has options of
obtaining early indicators of increasing or reducing the risk by having a more all-
inclusive view of the loan management (Koch, 2000).
According to Mudibo ( 2007) the savings and credit cooperative societies’ managers
need to manage their portfolio by understanding the risk posed by each credit and by
understanding how individual credit risk are interrelated. The credit manager must
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understand this stage because it is an interrelationship and can multiply risks many
times beyond what one expected because the risks were not related.
Sinkey, (1992) observes that it was just recently that when many banks had started
approving and adopting the new credit management concept when controlling credit
default. Also as noted by (Kimanthi, 2007), it was very resent in late 1990s when
SACCOs embraced the loan portfolio as a division in the general running of SACCOs
in many parts of Kenya. This acquired practice has provided many financial
institutions management such as banks and savings and credit cooperative societies’
with complete picture of how to manage credit risk profiling and other tolls of
analyzing and controlling credit risk (Sinkey, 1992).
2.2 Empirical Literature Review
According to Malimba & Ganesan (2009) with effective credit portfolio management,
not only helps in detecting poorly underwritten credit. In many ways it helps prevent
weak credit from being granted. Credit management also helps the credit officers to
be more industrious by knowing their work and being the subject of continues review
on the credit portfolio. The major challenge faced by majority of banks and financial
institutions in late 1980s and early 1990s was that there was failure by financial
institutions to monitor borrowers on basis of collateral values of assets before
advancing loans. Majority of banks during that period neglected acquiring opf
financial information of the credit borrowers in relation of real estate facts and
monitoring and evaluating quality of collaterals (Malimba & Ganesan, 2009). In their
result, many banks and financial institutions failed to identify early on signs quality of
assets to protect the institutions financials which in effects affected the institutions
18
assets and those of the stakeholders. Lack of monitoring in the financial institutions
by then lead to costly processes by senior management in determining the dimensions
and severity of the problematic loans which resulted to large losses.
2.2.1 Risk Identification
Jansson and Norrman (2004) define risk management process of focusing and
understanding the risks, and means of minimizing their impact. Kuusela and
Ollikainen (2008) describe the risk management process as risk identification,
measurement and analyzing, controlling and finance, evaluation and cost calculations.
Credit risk identification is very important when dealing with risk management in
financial institutions and more specifically in the savings and credit cooperative
societies’. However, to manage risk in SACCOs effectively the management should
identify the risk associated with every transaction before any loan advancement. The
first step on risk identification by SACCOs is by identifying the key risks which can
as well be revisited, reviewed and approved by the board of management with
guidance of the credit management committee. The SACCO also should also evaluate
the degree of loans advancement risks, the level of tolerance and time of repayment
among the positive and negative impact of credits if not controlled. The SACCO also
need to analyze the risk faced in the areas of credit management, liquidity, strategic
risks, interest rates risk and operations risks (Sinkey, 1992).
Commercial banks risks practice management according Markowitz (2002), is that
commercial banks mostly face credit portfolio risks due to management failures. But
Al-Tamimi (2002) in his observations stated that inspections by the branch managers
and the the financial statement analysis was the main procedure used in risk
19
identification by financial institutions. Majority of commercial banks and savings and
credit cooperative societies’ main technique for credit risk management is by putting
in place standards on credit scores, credit worthiness analysis, risks rating procedures
and availability of collaterals. In a more recent study by Al-Mazrooei (2007) also
established that in majority of banks the most common type of risk encountered
includes foreign exchange risk, followed closely by credit risk and then operation
risk. Al-Mazrooei (2007) advices that risk identification significantly influence risk
management practice more positively.
A study done Haron & Hin Hock (2007) specifically on banks risks identification and
risk mitigation identified inherent credit risk and credit market risk exposure. Haron
& Hin Hock, (2007) also illustrated the concept of displaced commercial risk that
were important to the banks by concluding that certain risk can be considered as
being inherent in their operations in the convectional banking institutions. Although
in comparison, the risk exposure of banks differs with savings and credit cooperative
societies’ the principals of credit risk management applies to both entities. Focus
Group (2007) additionally observed that the standards of risk management and capital
sufficiency are guiding principles that marks the first steps of providing good
standards by filling the regulatory gap that exist in portfolio management. In a study
by Griffins (2009) on twenty eight Islamic banks which looked at the perception of
management on risk management methods, the study established and concluded that
individual evaluation was the most important factor to consider as well as gathering
relevant information about the applicant and analyzing the information to determine
the credit worthiness before making any decision (Griffins, 2009).
20
2.2.2 Risk Analysis and assessments
According to Fatemi (2000) the typical process of analyzing risk normally has two
mechanisms. The first one is the financial analysis which includes analyzing financial
quantitatively and qualitatively. This is characterized by analyzing the available
financial applicant data and analyzing annual financial statement of applicant who is
the central and key determinant of default or repayment in this context. In such cases
the financial breakdown of the applicant is done by credit analysts and by following
the general guideline guiding the analysis to conform to organizational components
of credit analysis before credit considerations. Then the files are forwarded over to
credit manager for consideration or advice (Eldelshain 2005)
There are numerous concrete studies done on the risk analysis and assessment in
reference to measurement and mitigation of credit risk in financial institution. In
practice they all practice classify the different risk associated with credits
advancement and the most likely damages the possibly pose to the financial
institutions where Savings and credit cooperative societies are included (Fuser et al,
2009).
Fuser et al (2009) also points out that classification of credit defaults enables the
management to identify risk and evade the risk that may threaten the survival of the
corporation from which they may cause damage. Fatemi (2000) on other hand
observed that, there is an inverse relationship between the expected amount of loss
and its corresponding likelihood, and this include risk that can cause a high damage to
the institution, others included natural calamities such as earthquakes, landslide or
21
fire. However, risk occurs daily such as interest rate risk or foreign exchange risk
which causes some relatively minor losses although these risks can sometimes
influenced interest rates of a financial institution (Strutt, 2003).
In current status of many financial institutions such as banks and savings and credit
cooperative societies’ risk analysis goes behold evaluation to include other things like
decision making process in risk management(Griffins, 2009). Another important
aspect of credit management is brainstorming, which is the main sensitive practice
involving a group generating ideas. In this groups the people generate ideas from their
heads with a philosophy of nobody knows better or nobody is wrong which gets the
idea on board (Strutt, 2003). Brainstorming is quick and simple to apply but it lacks
the comprehensive approaches in comparison to the more sophisticated techniques
(Strutt, 2003).
Alexandra (2006) give a very comprehensive risk measurement and mitigation
method. Alexandra, identified some risk which can arise from financing activities in a
financial institutions which included categorizing in form of nature of profit and loss
sharing, source of funds especially in investments account holders among others.
Sundrararajan (2007) in his study concluded that the application of modern
approaches to risk measurement and particularly on credit is very vital to the overall
bank and other financial institutions credit portfolio management. Kimanthi (2007) on
other hand advices’ the financial institutions to adopt the new measurements
approaches and more in particular in the SACCOs because of the role they play and
the uniqueness mix of the risks in the because of the role they play and the
uniqueness mix of risk in the SACCOs contracts.
22
In a study by Olomolo (2002) established that loans repayment performance was
mostly affected by borrowers characteristics, lenders characteristics lenders and the
model of the loans applied. Kimanthi (2007) also found out that loan repayment
performance in some SACCOs in Meru South was mostly influenced by the
borrowers characteristic, lenders characteristics and more that the type of loans
advanced. Also identified by Kimanthi, was repayment challenges in form of loans
delinquency and default. According to Kilonzo (2011) in whatever case, the
borrowers cannot be held responsible for every case of default, but there is need to
examine whether the borrower and the lender have fulfilled all the loans requirement
as per the contract. Further it is important to establish the responsibilities and
obligations of all parties as indicated in the credit program rather than blaming the
borrowers all along.
2.2.3 Risk Monitoring and Mitigation
Ahlén (2012) established that credit manager’s procedure of approval of loans
applicants and revisiting old credit portfolio was the most important ingredient in
management of credit risks in the savings and credit cooperative society. Ahlén
(2012) further stresses that credit offering institutions need to put in place guidelines
which should be written for credit approval process as well as the approval authority.
Kilonzo (2011) observed that the board of directors and the management in a savings
and credit cooperative society need to always monitor loans, and be the approval
authority for new big loans and credits, to also renew the existing credit changes in
terms of existing conditions from the previous credits. Particular attention need to be
observed in reforming the guidelines and they should also be documented fully and
appropriately recorded. However, precautious loaning procedures in the savings and
23
credit cooperative society requires that every officer responsible for credit approval
and related businesses should be well equipped with customer relationship knowledge
so as to maintain credit client base for the institution. The approval authority should
also have customer relations responsibility as approval authority and should be
commensurate to the position within the management ranks as well as the expertise
required (Mwisho, 2001).
Alexandra (2006) attributes the main functions of risk management to include
monitor, measure and control credit risk in an institution. Alexandra (2006) further
observed that the effective risk management requires reporting and reviewing
structures to ensure that risks are effectively identified. Risks also need to be assessed
and appropriate responses control process put in place. Alexandra (2006) further
observes that risk monitoring and evaluation process make sure that risks
management practice are in line with procedure put in place. Also a proper risk
monitoring method need to be put in place to help the savings and credit cooperative
societies or any other financial institution to discover mistakes at early stages
(Alexandra, 2006).
In a study by Khan and Ahmad (2001), found out that on average risk management
practice officers did not measure, mitigate or monitor risk at 69%. However, 82%
implemented the policy and procedures, while internal control of bank was low at
50%. Al- Tamimi (2007) established that there was no significant deference between
United Arab Emirates (UAE) nationals and foreign banks in controlling and
monitoring credit risks. However, areas of interest rates risks were the second area of
24
main interest in the continuers monitoring and management practices of majority of
banks. On the same study it was established that majority of commercial banks made
patent difference between other financial institutions source of income and balance
sheet interest exposure. As such monitoring was the last step in the risk management
process among all studied banks (Akperan 2005).
2.2.4 Credit Risk Management Measurement
Many firms consider operation and financial ratios as a tool for determining credit
portfolio conditions and performances (Mudibo, 2007). Sinkey (2005) gained
popularity when he utilized discriminates warning model to identify and distinguish
problems in the banks and the model worked and has been applied by many financial
institutions globally. Sinkey (2005) on other hand examined savings and loan
industry. He used the rating system known as (CAMEL) capital, adequacy, assets
quality, management quality, earning and liquidity to identify the financial distress in
varying banks. The outcome of the study was financial soundness of majority of
banks.
CAMEL rating is applied by many banks as well as the central bank of Kenya for
assessing the soundness of financial institutions (CBK, 2010). However, majority of
investment banks generally view the interest rates and credit risk as classic part of
daily market risk. Through CAMEL systems majority of investment banks have been
able to develop detailed business trading risk management system to determine and
supervise exposure to credit risks (Kilonzo, 2011). However, this cannot be fully
suitable for financial establishment that have modest trading activities, but work
25
primarily on behalf of consumers, but the deficiency of sufficient trading systems in
the industry in some becomes stressful (Strutt, 2003). While there are some
shortcomings on underwritings management on market related credit, exposure of the
same presents good source of losses at the bank (Strutt, 2003). Kimathi (2007) also
notes that many credit problems can be avoided or mitigated if there is a strong
internal credit audits processes. However, in most of traditional banks lending,
competitive pressure and the growth of loan syndication techniques creates time
constrains that interfere with basic due diligence.
2.3 Summary and Research Gaps
Al- Tamimi (2007) studied the risk management systems Islamic banks in United
Arab Emirates (UAE), where he examined the perception of managers on credit risk
management procedures. Al- Tamimi study revealed that majority of Islamic banks
was also exposed to the same types of credit risks just like convectional banks
although it depended with the risk levels. Al- Tamimi (2007) also established that the
loan repayment pace was considerably affected by the characteristics of both the
lender and the borrower compounded by the loan characteristics. The identified
repayment challenges included loans delinquency and defaults. However, the
borrowers alone were not established to be the responsible for every problem which
arouse because everyone involved in the line had a role to play in the whole circuit.
Al- Tamimi finding was also supported by (Olomola, 2002) who advises that it is
important for the people concerned need and should examine the level at which the
both parties borrower and lender comply with loans contract as well as personality,
responsibility and tasks of parties concerned.
26
Basel (2009) studied the role of credit risk management committees and the following
was observed there was basic weakness on credit granting and monitoring process.
The other shortcoming established included the underwritings and management of
market related credit risks exposure, which in turn represented important source of
losses in the banks. However, many credit problems in the banks can be avoided or
mitigated by strong internal audit procedures, but many credit officers and managers
ignores the entire process to the detrimental of portfolio management. Besel (2009)
also noted that many banks had a challenge in carrying out a thoroughly and
substantial credit assessment with the basic due diligence.
Eales and Bosworth (2008) also established that the lack of validations and testing of
fresh loaning procedure was challenging many banking institutions. Many banks used
untested new lending methods and innovations in the areas of credit market on
dispensing loans without sound principles of benchmarks for leverage of granting the
loans. Eales and Bosworth (2008) further observed sound practices called for
application of basic principles on new type of credit creativity. Eales and Bosworth ,
also noted that some credits troubles happen due to skewed decision making
procedure by senior credit manageress in the banks, where (Kimanthi, 2007) also
observed was the same case in SACCOs where senior managers influenced credit
awarding without following procedures. The skewed decisions included giving credits
to organizations and companies they own or which they are members, credits to next
of keen and personal friends, credits to politicians or to people with reputation for
financial expertise and sometimes to meet personal agenda like creating personal
27
special relationships with rich and mighty in the community for personal gains
(Kimanthi, 2007).
Kilonzo (2011) observed that credit review does not only assist the savings and credit
cooperative society management to detect poorly underwritten credit but also assist in
preventing weak credit from being granted. Also noted was that credit officers in the
savings and credit cooperative society were more likely to be attentive with their
work when they knew their work was being evaluated and monitored. Kilonzo (2011)
also noted that the most common and very important problem which faced many
SACCOs in mid 2000 was the failure to monitor borrowers in form of collateral
value.
Kilonzo (2011) findings also concurred with previous study by (Kimathi, 2007)
which also established that many SACCOs ignored the role of obtaining constant
financial information of borrowers and real estate appraisal in evaluating the quality
of loans in their books, the collaterals at hand when approving loans. The result was
many SACCOs failed to see early signs that things were not good because the quality
of assets was not commensurate with the value of good or collaterals owned by
borrowers and to look for ways of curtailing their financial deterioration and
protection of SACCOs position. As observed was laxity by SACCOs lead to costly
process by senior management in determining the dimensions to be followed
(Kimathi, 2007).
Njoku (2007) opined that the failure by many SACCOs to perform adequately was
due to poor diligence in financial analysis and monitoring the borrowers to detect
28
credit-related challenges they face. In many SACCO related fraud losses were a result
of neglected inspection routine of collaterals like goods provided, showroom floor for
establishing the authentic and value of financial assets presented as collaterals and
also auditing the financial statements and carefully analyzing them. Njoku (2007)
stated that effective review as a SACCO department and independent collateral
appraisal is vital as a protecting measure to make sure credits officers and other
insiders does not conspire with borrowers.
In another study by Ogilo (2011) many savings and credit cooperative society have
experienced credit losses due to failure of applying sufficient caution with leveraged
credit arrangement. The credit extended to well influential borrowers were possibly
to have huge losses in non-payment and likewise, major formation like the take over
and debit improvement and planned strategies with written decision in general
intensified credit risks into the bank loans collection. Ogilo (2011) also observed that
many SACCOs in Kenya, credit lending actions involved giving loans with genuine
collaterals. However, in lending against real assets, savings and credit cooperative
societies unsuccessfully made insufficient valuation of correspondence between the
financial environment of the borrowers and the price changes. Thus, the liquidity of
the market value for the collateral assets declines. Thus, when the borrowers income
and the principle source of loan serving in attached to the to the property which is in
question, then it leads to deterioration of the borrowers income stream due to changes
in the industry compounded by regional economic problems. This mostly
accompanied by decline in assets value of the collaterals in question.
29
In another related study by Mwisho (2011), he concluded that assets based consumer
lending on either homes as equity and automotive financing, hand a similar
relationship because the financial health of the borrower were weak and thus
affecting the credit portfolio of the SACCO. In the same case, the SACCO related
problems included insufficient information of the account business cycle which
affects the lending. Prospects and assets values in such cases rise on an ascending
order in products cycle, where the credit analysis many incorporate astronomical
assumptions (Mwisho, 2011).
2.4 Conceptual Framework
The conceptual diagram below shows the interdependence of the study variable. The
conceptual framework shows the systematically organized variable interrelations. In
the framework the savings and credit cooperative societies’ loan portfolio depends on
the credit risk management for the savings and credit cooperative societies
sustainability and performance. The independent variables included risk
identification, analysis, monitoring and management.
Independent Variables Dependent Variable
Credit risk identification
Credit risk analysis
Credit risk monitoring
Credit risk management
Loan portfolio
among Sacco’s
30
2.5 Explanation of Study Valuables
2.5.1 Risk Identification
The risk identification techniques and instruments are the tools which savings and
credit cooperative societies has in place to identify the current and existing potential
of loan default on the leading activities in the savings and credit cooperative society.
This included the improvement, development and implementation of clearly defined
policies guiding loans portfolio management and lending policies to effectually
manage and control credit risks.
2.5.2 Risk Analysis
These are the techniques which the SACCO applies to calculate the credit worthy of
loaned. It involves examining the sources of capital to repay the loan as well as the
credit history of the borrowers in a stipulated length of time. The risk analysis
technique looks more keenly on the ability, policy requirements and credit manager
judgment of the loan seekers. Credit management policy are also used to check on the
risks involved to ascertain whether it is a good or a bad loan.
2.5.3 Risk Monitoring
Loan monitoring is the constant as well as timely process of monitoring effectually
the credit functions. It is also the art of the management to control the credit factions
and the membership loans. The risk monitoring faction is a continuers process in a
SACCO and it follows laid down guidelines to effectively monitor and control credit
portfolio. The process encompasses identifying the account problems, revisiting the
account frequently, making planned follow ups and taking corrective actions as per
the SACCO credit policy.
31
2.5.4 Risk Management
Risk management provides protection to an exposure which the savings and credit
cooperative society continue to hold. Savings and credit cooperative societies have to
put in place internal measures to manage credit portfolio by having regulatory capital
lending subject to meeting laid down conditions and approval regulations procedures.
This can include internal credit risk management systems.
32
CHAPTER THREE
RESEARCH DESIGN AND METHODOLOGY
3.0 Introduction
The section outlines research design and method applied. The chapter described the
study design applied and the target population . In addition, the chapter gives the
sampling design, the instruments used and the reliability and validity of instruments,
data collection procedure and data analysis method used are all described.
3.1 Research Design
The study applied the descriptive research design. The study adopted the descriptive
research design since it was to answer questions concerning the current trends,
conditions and status of the subjects under the study. Descriptive research design
describes the characteristics of the subjects under study (Cooper and Schindler, 2003).
Through the use of descriptive design, the researcher was able to have the whole
picture of credit portfolio in SACCOs. According to Cooper and Schindler (2003) a
descriptive design describes the existing conditions and attitudes through observation
and interpretation techniques. Through the descriptive the study was therefore able to
generalize the findings to all Sacco’s licensed by SASRA in Tharaka Nithi County .
3.2 Target Population
The target population for the study was 35 SACCOs operating in Tharaka Nithi
County, which are licenced by SASRA at as per 2017 According to SASRA there are
35 deposit taking SACCO operating in the county and they formed our target
population.
33
3.3 Sample and Sampling Technique
According to Cooper and Schindler (2003), when the target population is small less
than 100, a sample size of over 50% is adequate for descriptive study. As per the
population of the study, there were only 35 active SACCOs and thus, the researcher
opted to cover them all as a samples size which is over 50% and it was in line with
(Cooper and Schindler, 2003). Thus, the study sample size was 35 savings and credit
cooperative societies.
3.4 Research Instruments
The study used a questionnaire as the study instrument. The questionnaire was used to
collect the primary data. The primary data was collected using structured and
unstructured questions on the subject matter or study objectives. The study secondary
data was collected from journals, booklets, scholarly materials as well as SACCOs
and SASRA publications and financial statements.. The questionnaires was
administered by multiple approaches method which included (drop and pick method)
on the counter of respectful SACCOs. Emails and short messages (SMS) was used by
the researcher as a means of follow up and remainder.
3.5 Pilot Study
The research instrument was pilot tested in order to determine both reliability and
validity prior to administering it in the main study. Validity was determined through
expert opinion of five randomly chosen Sacco’s in the county while the reliability
was tested using the alpha coefficient. Only those factors in every construct that
returned alpha values equal to or greater than 0.7 (α ≥ 0.7) was be deemed reliable
and as such include in the final instrument.
34
3.5.1 Validity
To test the instrument’s validity, a pilot study was carried out. The content in the
research items were based on the study objectives. Unclear questions, or amendments
that could have been forgotten or left out in structuring of the questions were detected
and the tool revised in preparation for the main study thus improve the construct
validity.
3.5.2 Reliability Test
Reliability was ensured by subjecting the instruments to the test retest technique
whereby they were administered twice within a period of two weeks. The results from
the two tests was then correlated using Spearman’s correlation coefficient (rho). A
coefficient of 0.7 as Mugenda & Mugenda (2003) explains will be deemed reliable.
The instruments reliability was obtained after a pilot study of 5 SACCOs which were
not to be in the final study.
3.6 Data Collection Procedure
The researchers first sought for permission to collect data from MUA and the
SACCOs. After getting the permission the researchers administered the
questionnaires through multiple approaches method which included (drop and pick
method) on the counter of respectful SACCOs. Emails and short messages (SMS)
was used by the researcher as a means of follow up and remainder. The study
secondary data was collected from SARSA and SACCOs journal and publications, as
well as scholarly materials, books and internet.
3.7 Data Analysis and Presentation
Data analysis is the process of systematically coding the data, arranging and
analyzing compiled data from the field with the aim of increasing and understanding
35
them clearly (Mugenda and Mugenda, 2003). Data analysis was to enables one to
present the study findings more clearly. Before analysis, the data collected was
checked thoroughly after which it was corded to enable the researcher to summarize,
quantify and classify the data into forms that could suitably be used to prepare the
report. From the information, the study develop narratives and interpretive report in
by explaining the situation within the SACCOS.
A computer software Statistical Package for Social Science ( SPSS) version 22 was
used to analyze the quantitative data and to establish the relationship between credit
risk and credit portfolio. Qualitative data was analyzed using percentages, pie charts,
histogram and bar graphs. The data was tabulated for presentation by use of
frequency tables, pie charts, and graphs. To arrive at conclusions that go beyond the
immediate data alone and make inferences to accommodate general conditions,
inferential statistics was used. Conclusions, suggestions and recommendations was
drawn from the analysis.
3.8 Ethical Considerations
The study applied all ethical procedures in the study. The standards of conduct were
applied throughout by distinguishing the likes and dislikes of the respondents. The
considerations helped the researcher to understand and determine the difference
between acceptable and unacceptable behaviors. First, ethical standard prevented
against the fabrication or falsifying of data and therefore, promoted the pursuit of
knowledge and truth which was the primary goal of the study. Ethical behavior was
also critical for collaborative work because it encourages an environment of trust,
accountability, and mutual respect among researchers.
36
3.8.1 Informed Consent
The researcher adopted code of ethics and policies laid down by MUA University
which outline ethical behavior and guides researchers on the fields of study. These
coded addressed issues such as integrity, responsiveness, honesty, objectivity, respect
for all intellectual property, social responsibility, confidentiality, non-discrimination
among others.
3.8.2 Voluntary Participation
Informed consent and voluntary participation was highly up held. The principles of
willingness were followed to the later to guarantee the objectivity of all subjects of
the study who choose to participate out of their own free will . The respondents in the
study were fully informed of the procedure and any potential risk involved.
Confidentiality and anonymity of the respondents was highly protected.
3.8.3 Confidentiality
The researcher treated all the information obtained from the field with strict
confidentiality. The information got from the field was only accessible to the research
supervisor and the researcher only and was not to be divulged to any other person
without the consent of the University. However, the information disclosed to the
supervisors was based on principals of trust as per the University rules and
regulations.
3.8.4 Privacy
The privacy of a study can be defined in terms of a person having control over the
extent to which timing and circumstances of sharing oneself (physically, behavior or
intellectual) was protected. Having this in mind, the researcher ensured that the
37
information collected and information of the respondents acquired was secured to
grantee the privacy of each respondent.
3.8.5 Anonymity
Anonymity in research refers to data collected from respondents should be
completely unknown to anyone associated with the survey. The researcher made sure
that only the respondents knew that they participated in the survey and the researcher
mandate with the respondents ended there and the researcher cannot identify the
respondents. The researcher made sure that the data collected in the survey and all
possible identifying characteristics were separated from the publicly available data.
38
CHAPTER FOUR
RESEARCH FINDINGS AND DISCUSSIONS
4.0 Introduction
The chapter presents the data analysis and interpretations of the data on the
assessment of credit risk management practice adopted by SACCOs in Tharaka Nithi
County.
4.1 Data Collected and Analyzed
Questionnaires were distributed to the sampled 35 SACCOs in Tharaka Nithi out of
35 responded 4 declined to respond. This represented a response rate of 88%.
Mugenda and Mugenda (2003) observed that when the response rate of a study is
over 50% it is considered adequate for analysis and reporting, and when the response
rate is over 60% is good and 70% and above is very good for data analysis. The
response rate for the study was 88% which is adequate and very good as per Mugenda
and Mugenda (2003) recommendations.
Table 4.1 Overview of Data Collected
Population Number of
targeted
SACCOs (n)
Returned
Questionnaires
(r)
Non- Response
rate (tr)
SACCOs 35 31 4
Key: n = population; r = Returned Questionnaires; n-r = Non–response Error (12%)
39
4.2 Descriptive Statistics
4.2.1 Methods used in bringing credit risk awareness to staff Table
4.2 Method of credit risk awareness
Method Not at all least moderate Most used
Use of credit
manual
5 19 7
Regular
training
9 15 7
Using
supervisions
1 4 15 11
Regular
meetings
1 3 15 12
The study established that the most popular method of promoting credit risk
awareness in the SACCOs was through regular meetings and supervisions. . The use
0
10
20
30
40
50
60
70
Not at all Least Moderate Mostused
Regular meetings
Using supervision
Regular training
Use of Credit Manuals
40
of credit manuals is also regularly used but its application goes hand in hand with
regular meetings and supervision. Regular training also features amongst the
awareness methods but less prominently than the other three methods.
4.2.2 Credit default policy Table
4.3 Credit default period
Period Not at all Least Moderate Most used
1 month late payment 7 11 11
3 month late payment 1 1 1 22
6 month late payment 5 6 12 6
more than 12 months late
payment
5 4 13 7
0
5
10
15
20
25
30
35
40
45
50
more than 12 months latepayment
6 month late payment
3 month late payment
1 month late payment
41
Most SACCOs followed the 3-month (90 days) credit default policy as indicated by
the table above. Of the 31 SACCOs interviewed, 22 stated that they mostly use the 3-
month late payment period as the benchmark for credit default. However, it also
became apparent that the SACCOs use a combination of credit default policies as
opposed to just sticking to one but all in all the 90- day late payment was the most
popular followed by the 1-month (30-day) benchmark.
In the same area, it was established that 28 (80%) of SACCOs reviewed their credit
policy annually, while the remaining SACCOs reviewed their credit policy in half-
yearly. Further, majority of SACCOs representing 28 (80%) strongly agreed that
credit risk management practice had a positive impact on the SACCOs, because it
ensured there was good organization on caring out responsibilities to meet the credit
portfolio objectives.
4.2.3 Favored credit risk management practices in managing credit risk
exposure
Chart 4.1 Favored credit risk management practices
Credit enhancement 5
Credit control policy 12
Credit approval 14
Credit limit 23
Credit diversification 4
Credit documentation 5
42
Credit risk managers in SACCOs use a combination of methods but the most favored
one was the credit limit followed by credit approval and credit control policy
respectively as shown in the graph above. The credit limit does not only cap the
upside risk but it also ensures a wider distribution of loans to SACCO members as no
one person or group can get a disproportionately high loan amount at the expense of
others members soliciting for loans.
4.2.4 Credit risk measurements used by SACCOs
Chart 4.2 Credit risk measure(s) used by SACCOs
percentages
Credit scoring mechanism 24.14
Qualitative models 3.45
Newer models 13.79
Others 58.62
Most of the SACCOs interviewed indicated that they used qualitative methods while
the credit scoring system was applied by very few. This may be indicative that
SACCOs have not enhanced their capacity for credit assessment and may thus need to
investment more in objective systems rather than relying on subjective approaches
such as the qualitative approach. On the other hand, most SACCOs lend to members
43
who in many cases have a consistent monthly income stream and as such they use
these streams of income as security. As a result, they may not need a complex
measurement system to regulate credit given that client incomes are to a large extent
predictable and consistent.
4.2.5 People responsible for credit policy formulation
Table 4.4 Credit policy formulation pane
People Not at all Least Moderate Most used
Executive
Management
1 3 12 15
Board of
directors
12 19
Credit
committees
2 9 20
Credit
managers
4 18 9
Credit committees, boards of directors and credit managers respectively for the most
part are responsible for credit policy formulation in the SACCOs interviewed. The
executive management also registered a sizeable impact on credit policy albeit
somewhat diminished when compared to the first three avenues of credit policy
formulation.
44
4.2.6 Credit risk management practices in the respective SACCOs
Table 4.5 Credit risk management practices
Strongly
agree
Agree Not
Sure
Disagree Strongly
Disagree
Credit decisions are made after
standardization
11 10 10
Credits must be monitored and
reviewed
24 7
Portfolio managers should
watch over the loan
21 6 4
Member lending facility is
reported to the credit
11 15 4 1
Risk management practices are
monitored and set
13 9 9
Most respondents agreed on two things; credit must be monitored and reviewed and
that portfolio managers should watch over the loan. This is reflective of the
operations of most SACCOs in which there is regular monitoring of the loans and
loan portfolio managers are made to account for loan performance.
45
4.2.7 Initial screening and risk assessment factors to SACCO lending
Table 4.6 Screening and risk assessment factors
Factor Not at
all
Least Moderate Most used
Character of
borrower
1 9 21
Capacity 1 17 13
Conditions 15 16
Collateral/ Security 1 16 14
Other
The character of the borrower was the most prominent criteria used in screening of
potential borrowers amongst the 31 SACCOs. The SACCOs also set some conditions
mainly involving duration of membership and amount saved. Collateral was also used
but it was not the core criteria given that most SACCOs are able to attach member’s
incomes (salaries) and hence use these income flows as security. On the other hand,
SACCOs that do not deal with salaried members, such as those comprising business
people and artisans, are keener on collateral.
46
4.2.8 Methods of loan recovery for clients experiencing difficulty in repayment
Table 4.7 Methods of loan recovery
Not at
all
Least Moderate Fair Great
Letters of credit and telephone calls 5 9 9 2 6
Sale of property to recover money 12 13 3 3
Debt write-off and account it as bad
debt
6 14 6 4
Write off interest and allow them to
pay principal
7 12 4 7 1
Debt collection agencies 11 8 7 3 2
Legal action 12 8 3 7
Other 1
The responses brought out the fact that SACCOs try to avoid sale of property, debt
collection agencies and legal action and as such these three loan default redress
mechanisms are normally applied as a last resort. However, the SACCOs also try to
avoid debt and interest write offs and instead prefer loan renegotiation and
restructuring. All in all, letters of credit and telephone calls appear to be the most
preferred first line of defense in dealing with clients who fall behind their loan
repayment schedules.
47
4.3 Factor Analysis
Table 4.8: Total Variance Explained
Component Initial Eigen Values Extraction Sums of Squared Loadings
Total % of
Variance
Cumulative
%
Total % of
Variance
Cumulative
%
1 6.336 90.516 90.516 6.336 90.516 90.516
2 .401 5.733 96.249
3 .260 3.709 99.958
4 .003 0.42 100.000
5 2.334E-16 3.349E-15 100.000
6 9.467E-17 1.352E-15 100.000
7 -2.447E-17 -3.495E-16 100.000
Component (Factor) Description
1. Sound credit risk management practices are built on good-quality portfolio
management.
2. Better portfolio monitoring and delinquency tracking through the use of
appropriate reporting tools help in delinquency management.
3. Credit officers must possess adequate appraisal and monitoring skills,
experience and good knowledge of credit risk management practices.
4. Customers are offered good free consultant services.
48
5. The use of collateral particularly fixed assets to recover defaulted loans is
successful to some extent in loan default recovery.
The factor analysis indicates that 90.5% of the respondents believe that sound credit
risk management practices are built on good quality portfolio management This is
indicative that the SACCOs interviewed tend to focus on the quality of portfolio
management but have not to a large extent assimilated credit risk management
processes and tools as being part and parcel of sound credit portfolio management.
4.4 Summary and Implications of Findings
The study established that the most common method of supporting credit portfolio
management awareness in the SACCOs staff was through supervision and through
regular meetings. Out of 31 SACCOs, 22 of the posed that they have three months
(90 days) credit default policy which every borrower should abide with to manage
credit portfolio. On other hand 28 SACCOs stated that they reviewed their credit
policy framework annually, while the remaining SACCOs reviewed their credit
policy every year (annually). Majority of SACCOs management (28) strongly agreed
that good credit risk management practice impacted positively on credit portfolio
management and ensured efficiency in caring out the obligation of the SACCOs
objectives. Credit risk managers in SACCOs use a combination of methods but the
most favored one was the credit limit followed by credit approval and credit control
policy respectively. Most of the SACCOs interviewed indicated that they used
qualitative methods while the credit scoring system was applied by very few. Most
respondents agreed on two things; credit must be monitored and reviewed and that
portfolio managers should watch over the loan. This is reflective of the operations of
49
most SACCOs in which there is regular monitoring of the loans and loan portfolio
managers are made to account for loan performance. Perhaps this also explains why
the SACCOs rely on more subjective lending criteria through the use of qualitative
models as opposed to the more objective credit scoring approaches.
50
CHAPTER FIVE
SUMMARY, RECOMMENDATIONS AND CONCLUSION
5.0 Introduction
The main aim of the study was to analyze the effects of credit risk management
practices applied by SACCOs on loan portfolio in Tharaka Nithi county. To satisfy
the objectives of the study, primary data was collected from 31 SACCOs. The
secondary data for the study was collected from books, scholarly materials and from
SASRA and SACCOs booklets, journals, credit polices and financial statements. The
conclusion of the study was deduced and subsequently policy recommendations for
SACCOs were indicated. The limitations encountered in the study were enumerated
and suggestion for further study stated.
5.2 Conclusions
In conclusion the most common and popular method which SACCOs promotes credit
risk knowledge among it staff was through regular meetings and supervisions on one
on one basis. Majority of SACCOs hand a 3-months (90 days) credit default policy
which ensured that the credit portfolio was managed well. In the same area, it was
SACCOs reviewed their credit policy annually, while other SACCOs reviewed their
credit policy in half-yearly. Also noted was that some SACCOs ignored the role of
obtaining periodic financial information of borrowers and real estate appraisals to be
used in evaluating the quality of loans in their books and the adequacy of collaratel in
hand. Further, majority of SACCOs respondents strongly agreed that credit risk
management practice had a positive impact on the SACCOs, because it ensured there
51
was good organization on caring out responsibilities to meet the credit portfolio
objectives. The finding concurs with (Kimathi,2007) who observed that credit review
does not only assist the savings and credit cooperative society management to detect
poorly underwritten credits but also assists in preventing weak credit from being
granted. The fact that most SACCOs prefer to review credit policy annually may be
compounded by issues of size and logistics as some of them have countrywide or
regional reach and as such frequent changes in policy may lead to a dysfunction in
their operations.
Further it is important for management of the SACCOs should and need to examine
whether the loans borrowers and the lending financial institutions comply with loans
contracts. The responsibilities and obligations of both parties need to be understood
before extending loans. Njoku (2007) stated that an effective review and independent
collateral appraisals are important as protective measure to ensure credits officers and
other insiders are not colluding with borrowers.
Credit risk managers in SACCOs use a combination of methods but the most favored
one was the credit limit followed by credit approval and credit control policy
respectively. Most of the SACCOs interviewed indicated that they used qualitative
methods while the credit scoring system was applied by very few. Most respondents
agreed on two things; credit must be monitored and reviewed and that portfolio
managers should watch over the loan. This is reflective of the operations of most
SACCOs in which there is regular monitoring of the loans and loan portfolio
managers are made to account for loan performance. However, this is also reflective
of the fact that most SACCOs do not have, to a large extent, standardized approaches
52
to credit risk management and much is left to the discretion of the portfolio
managers. Perhaps this also explains why the SACCOs rely on more subjective
lending criteria through the use of qualitative models as opposed to the more
objective quantitative methods such as credit scoring. The study corroborates with
that of Branch (2005) which stated that credit management procedure has a profound
influence financial stability of a SACCO. However, the main decision in credit
management include decision by finance staff, loan management, asset management
and production innovations.
5.3 Policy Recommendations
The study have shown that for the most part SACCOs rely on the on the
watchfulness and keenness of credit managers skill on portfolio managers for useful
credit risk management and this indicates the absence of a standardized and objective
credit risk management system in most SACCOs. As they expand to incorporate more
members in the various regions of the country the approach of relying on individual
managers may prove to be inadequate and serve to increase the loans defaults.
Accordingly, it is imperative that SACCOs adopt standardized credit risk
management practices to avert the risk of default emanating from personalized
systems.
5.4 Limitations of the Study
A study of this magnitude would not go without some limitations, and the first one
was being a qualitative in nature and as such did not assess the financial performance
of the SACCOs to back the questionnaire on the effect of credit risk management on
loans portfolio among SACCOS The scope of the study was very much restricted
53
geographically to SACCOs in the environs of Tharaka Nithi due to the limitation of
time.
5.5 Suggestions for further study
Given the qualitative character of the study there is need for another study that would
assess whether SACCOs use new technological tools in managing credit portfolios. In
this age of micro finance advocacy a study may also be conducted to assess the
economic impact of SACCO loans on the members who borrow from them and see
whether there has been a marked improvement in their economic welfare on
borrowing the loans.
54
REFERENCES
Ahlen, M. (2012). Rural Member-Based Microfinance Institutions. A fled study on
assessing the impact of SACCOs in Babati District, Tanzania. Thesis,
Souderton University.
Akperan, J. (2005) Bank Regulatory, Risk Assets and Income of banks in Nigeria.
Available at: http://www.ndic-ng.com/pdf/adam.pdf (Accessed 08 March
2010).
Alexandra, F. (2006). Effect of wholesale lending to SACCOs in Uganda. Retrieved
from www.LSBF.org.uk/Finance.
Basel, T. (2009) Principles of credit risk management. Basel committees on banking
supervisory. Basel Journal 2010.
Cheron, E.J. Boidin, H. and Daghfoun, M (2009). Basic financial service of low
income individual comparative study in Canada. International journal of
banking and marketing, 17(3) 23-54.
Chipembere, R. (2009). Unlocking funding opportunities for farmers through grass
root SACCOs. Available fromwww.snvworld.org/en/document/mz
GOK, (2012). Economic Survey on National Empowerment Strategy and
Implementation Plan Nairobi Kenya: Government Printers, 2012.
FG (2007). Focus group on credit risk management industry in best practices.
Available at: http://www.bangladeshbank.org/creditrisks.pdf
(Accessed 02 Oct 2016).
Higgins, P (2009). Hyper- Competitiveness can lead to poor credit assessment in
Australian banks and financial institutions. Journal of Banking
Management vol, (2) 12-15.
Kessy, S. (2010). The impact of traing on performance of Micro and small entrprices
sarved by by Micro-finance institutions in Tanzania.
Kilonzo, S. (2011).Consultative Forum On The Proposed Market for SMEs. Nairobi:
Capital Markets Authority.
55
Kimathi .B. (2007) Factors affecting SACCOs performance in Meru South District,
case of Tharaka Nithi Teachers Sacoo. (MA) Unedited .Nairobi
University.
Kimuyu, P.K. & Omiti, J. (2010). Institutional impediments in accessing credit by
Micro and small scale enterprises in Kenya. Nairobi; Macmillan
publishers.
Njoku, J.E. (2007). Determinants of loan repayment under special emergency loan
scheme in Nigeria. Journal of Nigerian Banks, Vol (4) 5-7
Mugenda, O and Mugenda, A (2003). Research Methods: Quantitive and Qualitatitive
approaches.
Michael, S (2008). The quality theory verses the bill doctrine in colonial America.
Economic journal of credit review.USA.
Markowitz, H. (2002). Portfolio selection. Journal of finance, vol (9) pp 2-7.
Mwisho, A.AM (2001). Basic lending condition and procedures in commercial banks.
The journal of accounting, vol. 12, pp 15-23.
Ogilo, S (2001). The impact of credit risk management of financial performance in
commercial banks in Kenya. Unpublished PHD Thesis. Kenyatta university.
Omolola, S (2000). Determinants of small scale loans defaulting in Nigeria. Nigeria
Micro-finance institutions journal
World Bank (2012).Financial sector Assessment: Financial Sector assessment
Program. World Development Report.
56
APPENDICES
APPENDIX I: LETTER OF INTRODUCTION
MARY CIRINDI JOSEPH
c/o
MANAGEMENT UNIVERSITY OF AFRICA
Dear Respondent,
RE: THE EFFECTS OF CREDIT RISK MANAGEMENT ON LOAN PORTFOLIO
AMONG SACCOS IN THARAKA NITHI COUNTY, KENYA
My name is Mary Cirindi Joseph, a student at Management University of Africa
currently caring out a research on the above topic. The research is part of requirement
for my programme in the University. Kindly fill the questionnaire as honestly as
possible to enable this research to be successful. The information you give is needed
purely for academic research and will be treated as confidential.
Your assistance and cooperation is highly appreciated. Thank you.
Yours truly,
MARY CIRINDI JOSEPH
57
APPENDIX 1I: QUESTIONAIRE
Part A: General information
Name of Sacco (optional)…………………………………..
Number of years the Sacco has been operatin………………
Current designation in Sacco…………………………..
Years of service in the Sacco………………………………
Type of loan products offered by the Sacco:
Normal loan[ ] Instant Loan[ ]
Development Loan [ ] Emergency Loan [ ]
School fee Loan [ ] Others (specify) [ ]
Part B: Credit Risk Management Practices
1. What ways does your SACCO employ to bring credit risk awareness to staff?
Parties 1 2 3 4 5
Use of Credit Manuals
Regular training
Using supervision on one to one
basis
Regular meetings
58
2. When does your organization decide that a client has defaulted on loan
repayment?
Period
1 month late payment
3 month late payment
6 month late payment
more than 12 months late payment
3. How regularly do you review your credit policy?
Quarterly…………………………………………………. [ ]
Half yearly ………………………………………………. [ ]
Yearly…………………………………………………….. [ ]
Other specify ………………………………………………
4. The credit risk management practice in SACCOs ensures efficiency in its
obligations of meeting the objectives.
Strong Disagree [ ]
Disagree [ ]
Neutral [ ]
Agree [ ]
Strongly Agree[ ]
5. Is it paramount for SACCOs to manage credit risks that it’s exposed to?
Yes [ ]
No [ ]
If yes, explain your answer…………………………………………………….
59
6. Which practices among the following do you consider when managing credit
risk exposure?
a) Credit enhancement [ ] b) Credit control policy [ ]
c) Credit approval [ ] d) Credit limit [ ]
d) Credit documentation [ ]
e) Diversification across union members [ ]
f) Any other specify ………………………………
7a). Do you use any credit risk management measures in your SACCO?
Yes [ ]
No [ ]
b). If yes please indicate which credit risk management measures used. (Tick
where applicable)
Credit Scoring Mechanism…………………………. [ ]
Qualitative models …………………………………… [ ]
Newer models ………………………………………… [ ]
Other specify ………………………………………….
For questions 8 up to12, Tick appropriately where 1 represents least considered and 5
represents most considered.
8. Tick below the people who formulate your credit policy.
People Not at all least moderate most
Executive
management
Board of directors
Credit committee
60
Credit managers
Employees’
suggestions
9. To what extent do you agree with each of the following statement about credit risk
management practice in your SACCOs?
Procedure Strongly
agree
Agree Neutral Disagree Strongly
disagree
Credit decisions are
made after
standardization
process and
documentation is
required.
Credits must be
monitored and
reviewed periodically
for quality credit
control.
Portfolio managers
should watch over the
loan portfolio's degree
of concentration and
exposure.
Member lending
facility is reported to
the credit risk
management
committee.
Risk management
practices are
monitored
and set by the credit
committee
61
10. Which factor(s) among the following does your SACCO use as an initial
screening and risk assessment device before awarding credit to a customer?
Factor 1 2 3 4 5
Character of borrower
Capacity
Conditions
Collateral/ Security
Other
Any other, Specify…………………………………………
11. To what extent does your SACCO apply the following methods in loan recovery
when it is difficulty for the client to repay the loan on time?
Method Not at
all
Least
extent
Moderate Fair
extent
Great
extent
Letters of credit and telephone
calls.
Sale of the property to recover the
money.
Write the debt off and account it
as bad debts.
Write off interest and allow them
to pay the principle.
Debt collection agencies.
Legal action.
62
Any other, specify, Please specify………………………
12. To what extent do you agree with each of the following statement about credit
risk management in your SACCOs?
Statement Strongly
agree
Agree Neutral Disagree Strongly
disagree
Credit risk management is
essential to optimizing
the performance of the
SACCO
Sound credit risk
management practices are
built on good-quality
portfolio management.
Credit unions have adopted
credit documentation as a
ways of managing credit
risk.
The use of collateral
particularly fixed assets to
recover defaulted loans is
successful to some extent in
recovering defaulted loan.
Better portfolio monitoring
and delinquency tracking
through the use of
appropriate reporting tools
help in delinquency
management.
Credit officer’s must posses
adequate appraisal and
monitoring skills, experience
and good knowledge of
credit risk management
practices.
Customers are offered good
free consultant service.
63
64
65
66
67